News analysis

A case of diminishing returns for central banks

NEW YORK • Central banks are running into diminishing returns from their use of easy monetary policies, seven years after first championing quantitative easing to save the world from depression.

But, the Bank of Japan's (BOJ) surprise shift to negative interest rates, the European Central Bank's (ECB) signal that it will deploy new stimulus next month and speculation that the Federal Reserve will slow its campaign to raise interest rates have failed to bring cheer to the markets.

The Standard & Poor's 500 Index fell on Monday to a 22-month low as bank shares dropped to their weakest since 2013. Japan's benchmark equity index careened yesterday towards levels unseen since 2014 and the yield on the country's 10-year bonds dipped below zero for the first time.

Stocks are also falling in Europe, where memories of the region's debt crisis are being stirred by rising bond yields in Portugal and a slide in Greek banks. Underscoring the lack of policy potency is that the yen and euro are both climbing even as policy eases.

"Central banks' ultra-loose monetary policy is putting the world economy at risk," said Mr William White, a senior adviser to the Organisation for Economic Cooperation and Development (OECD).

Negative interest rates and quantitative-easing programmes from the United States to Japan may have unintended side effects such as higher debt levels for both sovereigns and consumers, he said.

If interest rates go deeper into negative territory, profit margins will be squeezed harder, and if banks are not profitable, they are less able to add to the capital buffers that let them operate safely, The Economist said. That would put pressure on banks to charge their own customers for deposits.

Monetary tightening from the Federal Reserve and, eventually, the Bank of England, and easing by the BOJ and ECB were supposed to drive financial markets this year.

BOJ governor Haruhiko Kuroda said in the first week of this month that the central bank will charge commercial banks for holding deposits with it. The tool has been useful for its peers in Denmark, Sweden, Switzerland and the euro area where interest rate of minus 0.3 per cent applies to almost all reserves. But, that has resulted in an unavoidable squeeze on profits of banks.

If interest rates go deeper into negative territory, profit margins will be squeezed harder, and if banks are not profitable, they are less able to add to the capital buffers that let them operate safely, The Economist said. That would put pressure on banks to charge their own customers for deposits.

Such outcomes can constrain Mr Kuroda's claim that there is no limit to measures to ease monetary policy as he tries to bring inflation levels to 2 per cent.

"Negative rates on reserves are actually squeezing bank profits, and this is something we don't want in these circumstances, we want them to build up their capital buffets," Mr White told Bloomberg TV. "This is all experimental."

Japan's bond yields have fallen, global stocks extended a rout yesterday as European shares declined, while yen reached its strongest since 2014.

"The markets are wondering, well, we've had these non- conventional monetary policy experiments for the last six or seven years and they haven't caused a sustainable boost to global growth, so what will the latest moves do," Mr Shane Oliver of AMP Capital Investors in Sydney told Bloomberg. "It's a reasonable question to ask given the events of the last few weeks."

The shifts may strengthen the argument of opponents to the "whatever it takes" approach by central banks to stoke inflation expectations, appetites for risk and, ultimately, economic growth.

Investors are looking for ECB president Mario Draghi to ease policy in the euro area further as early as next month as the slump in oil drags down inflation, while the Bank of England has dialled back talk of increasing rates, and bets on the Federal Reserve hiking rates again are retreating.

Traders unwound bets for this year as concern intensified over China's capacity to deal with its slowing economy, and the impact of Japan's negative interest rates.

The distress that has brought global equities to the brink of a bear market this year is flaring in the credit space, with the cost of protecting against company defaults surging worldwide.

"We had a bubble in people's expectations of the power of central banks," said Mr Soichiro Monji, chief strategist at Tokyo- based Daiwa SB Investments. "And now we're seeing that bubble burst."

In the US, officials are now grappling with concerns that the economy's slowdown in the fourth quarter may continue amid ongoing stock market declines and weaker investment due to the stronger dollar, the oil slump and softening global demand.

Investors are pricing in a less than 50 per cent probability of another increase this year.

Federal Reserve chair Janet Yellen "has to recognise the troublesome markets and that it's difficult to quantify their impact," said Mr Torsten Slok, chief international economist at Deutsche Bank in New York. "If inflation and employment deteriorate then she won't hike (rates)," he said.

A version of this article appeared in the print edition of The Straits Times on February 10, 2016, with the headline 'A case of diminishing returns for central banks'. Print Edition | Subscribe

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